School's out for most students, but test-prep company Princeton Review (NASDAQ:REVU) has one more test to pass before summer vacation begins. Q2 2006 grades will be posted tomorrow morning.

What analysts say:

  • Buy, sell, or waffle? Exactly one analyst follows Princeton and rates the company a hold.
  • Revenues. This analyst expects to see 12% sales growth tomorrow at $33.4 million .
  • Earnings. . and a loss of $0.03 per share.

What management says:
Back in May, CEO John Katzman shared some happy news with shareholders: "Revenue is expected to be strong, [and] we expect to be profitable for the year." But if Princeton's lone, long-suffering analyst has done some good homework, then Princeton will have a hard time achieving profitability this year. The firm's $0.08 first-quarter loss, if compounded by the $0.03 the analyst predicts will be reported lost tomorrow, would mean it would need to earn more than $0.11 in the second half if Katzman is to deliver on his promises.

What management does:
Key to achieving profitability, it seems, are two things: increasing revenue and reducing costs. Over the past two quarters, Princeton did well on part 1 of this test, growing its revenues by 10%. But on part 2, reducing costs, the results were, at best, mixed. Operating costs grew by just 6%, so give it a B-plus there -- slowing down an increase does not a reduction make. However, cost of services rose 27%, and that drove gross margins down and operating margins down with them; it also torpedoed any chance of a profit for the quarter. (P.S. -- ignore the rolling net margin line for the time being. It's been skewed by hefty charges the company took in the quarter ended in December 2004.)

Margins %

12/04

3/05

6/05

9/05

12/05

3/06

Gross

64.3

64.5

63.4

64.1

62.0

60.9

Op.

(4.6)

(3.3)

(4.4)

(3.2)

(3.3)

(4.8)

Net

(26.7)

(25.0)

(25.5)

(22.9)

(2.7)

(4.0)
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
To review: Princeton has two objectives. One, growing revenues, seems to be proceeding nicely. But on part 2, costs, the situation remains bleak. Examining the firm's three divisions in order, it spent 11% more on cost of services in its flagship test-prep division and achieved 9% sales growth in return. Admissions services, the smallest business unit, was the fastest grower last quarter at 13%, but it incurred 67% higher cost of services in achieving this growth. Finally, 17% higher costs in the K-12 division yielded a 13% decline in revenue.

So what we have here -- at least so far -- is a Catch-22 situation. The company can grow its revenues, as it has said it must. But to do so -- again, to date -- it's had to abandon its pledge to reduce costs and has increased them instead. Until Princeton figures out a magic formula to accomplish both goals at once, its aim of attaining profitability must prove elusive.

Competitors:

  • WashingtonPost (NYSE:WPO)
  • Reed Elsevier (NASDAQ:ENL)
  • McGraw-Hill (NYSE:MHP)
  • Educate (NASDAQ:EEEE)

Customers:

  • PlatoLearning (NASDAQ:TUTR)

Want the Fool's skinny on Princeton's Q1 performance? My fellow Fool Steven Mallas has you covered. Read his analysis of the first-quarter results in "Princeton Needs Summer School."

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Fool contributorRich Smithdoes not own shares of any company named above.